I appreciate the opportunity to present the views
of FEI before this presidential commission and, further, I wish to convey
FEI's willingness to provide technical assistance to you and your staff
during the course of your work on this very important subject.
Why Capital Budgeting?
As many of you may know, the private sector has gone through a wrenching process of re-engineering and downsizing over the past 15 years. Virtually every business has had to reassess its mission, priorities, and the ability to deliver a required level of goods and services at a lower cost and with greater efficiency. Those of us in the corporate financial community know how critical and painful this process can be. We had to do it because of the efficient laws of survival in the global marketplace. During this period of multi-billion dollar budget surpluses, we strongly recommend that the Federal government emulate the private sector experience.
Central to private sector re-engineering has been employment of a highly disciplined mission definition and capital allocation process conducted in a prescribed cycle schedule. Pivotal to these efforts is the commitment to long-term fixed assets which will drive much of the operating budgets of future years.
The importance of capital budgeting in the private sector cannot be overemphasized. Capital budgeting forces companies to develop long-term strategies on how most efficiently to accomplish their business objectives and to link cost to the fulfillment of that mission. By doing so, it subjects the process to serious analysis for setting priorities and allocating scarce resources.
Given the impact on long-term mission accomplishment and the financial commitments which are embodied in the capital budget, ft is imperative that it be analyzed, approved and accounted for in a process totally separate from that for current operations. To lump them together as is currently done in the Federal unified budget is to obscure and frustrate the role it should play.
It must be understood that the presentations accompanying
the approved Federal budgets that break out capital appropriations for
fixed assets and the other "investments" are done after the fact and are
not separately considered in the decision-making process. Taking this approach
makes it virtually impossible to adopt the disciplined approach of the
private sector to define the mission and allocate capital appropriately
in support of it.
The Mission Definition and Capital Allocation Cycle
Capital budgeting forces companies to develop a long-term (usually five years) strategic plan to fulfill stated goals and objectives. In developing the strategic plan, companies first determine what their capital asset requirements will be to accomplish the mission. Once completed, the costs to fund the capital assets will be calculated.
Determining the ability to fund capital projects requires companies to prioritize projects in order to accomplish the stated objectives and best fulfill the overall mission within funding constraints. In the private sector, companies utilize analytical tools, such as positive net present value, to evaluate investment criteria and determine the relative value of competing projects and to make the critical priority decisions.
Once this process is complete and the decision to move ahead with the capital investment is made, a system must be put in place that periodically tracks the progress of the investment's critical path to ensure that the project is meeting its stated objectives in a timely manner and within prescribed expenditure limits.
In the private sector, the financial reporting system is used to monitor the progress of such capital projects - produced on a monthly, quarterly, and annual basis. Safeguards such as periodic audits are performed regularly to ensure the accuracy of the financial reporting system and accomplishment of objectives.
In condensed form, these reports are then reviewed by executive management and often by a board of directors to evaluate the effectiveness of the strategic plan and the underlying capital investments. The board of directors uses this information as the basis for approving the strategic plan for the ensuing five years, with annual reviews to assess its status and make modifications where appropriate. This process helps to ensure that the implementation stays on track and provides the flexibility to adjust to a change in conditions.
If the process is adopted as FEI proposes, this review
and approval would be done at the federal level by Congress through its
oversight committees on Governmental Reform and Oversight and Governmental
Definition of Capital Assets
A distinction must be drawn between the broad concept of federal investment spending for long-term benefits and the included, but more narrow function, of the planning, executing and tracking of physical capital asset acquisition. Of the proposed 1999 investment spending of $237 billion, $77 billion would be for research and development, $50 million for education and training and $113 billion for physical capital. While unquestionably vital to future development of the country's potential, FEI would propose that the first two categories be separated from the conceptual framework for capital budgeting we would propose to explore.
It should also be noted that of the $113 billion of physical capital, $50 billion will be for national defense, $19 billion for non-defense and $44 billion for grants to state and local government for infrastructure projects they would own and operate. This last category is effectively expensed despite its long-term nature. While we feel it is important to recapture oversight of these investments, the associated accounting complications require this to be a later effort. However, there are ways that a parallel effort involving federally-owned projects could provide important insights.
Within the $50 billion of defense expenditures, a significant portion representing weapons systems will be categorized as stewardship assets and effectively expensed. This is dictated by Financial Accounting Standards Advisory Board pronouncements citing a variety of concerns. Among these is the uncertain life of weapons systems committed to hostile utilization environment which precedes reasonable, predictable lives and hence gives rise to questionable depreciation schedules. While FEI appreciates these concerns, we believe that it is possible to deal effectively with these assets and would propose to explore several concepts.
Based on our thinking on these matters, FEI would urge consideration of three pilot projects that could be useful in examining alternative approaches to current procedures in the area of capital budgeting.
Within the Mission Definition and Capital Allocation process, decisions must be made on the present and future deployment of various categories of capital investment which support mission accomplishment.
Embracing all of the definition of investment which is applied to all federal programs within the current conceptual framework would obviously overwhelm the effort. Therefore, FEI has chosen to narrow the definition initially to tangible fixed assets and to address a limited number of program types.
This would include:
Because of the long-term commitments created by the capital budgeting process for fixed assets, it is essential that ft be analyzed and justified in a process separate from that used for other forms of federal investment, current operating expenses and discretionary spending.
However, moving to capital budgeting does raise some additional issues. These include violating existing policy and law concerning the appropriation process, the inclusion of depreciation in operating budgets,, employment of deficit financing of investments and possible abuses such as deflecting costs between operating and capital accounts!
While recognizing these concerns, FEI believes that it is possible to create systems that would deal effectively with each of these issues. This would include protecting the concepts of full funding and up-front scoring along with retention of the visibility of the unified budget. To that end, FEI has proposed to Congress a pilot program to test the applicability of these systems to discrete federal programs that are representative of three classes of fixed asset investment:
Systems and procedures would be devised and tested to prove their efficacy and their ability to satisfy the concerns expressed by observers. Each of the three programs would then be evaluated for possible broader application and, hopefully, eventual adoption as modified and improved for general use in the Federal budget.
Budget decisions made today have long-term ramifications for the health of the nation's economy. In this current budget environment, making informed budget decisions could mean the difference between sustained surpluses or a return to multi-billion dollar deficits. This is where capital budgeting can play a vital role. Capital budgets would be important tools for Congress and the President to have at their disposal as they work toward a more efficiently-run government.
1.) It provides a means to improve the prioritization of capital spending and ensure that prescribed goals are achieved.
2.) It will enhance the understanding and communication among those individuals charged with implementing these projects.
3.) The capital budgeting process will provide a disciplined approach to this critical spending necessity which allows for a coherent review component and accountability for the results.
Clearly, there are important and obvious differences between managing the government and managing corporations. However, this does not mean that sound business management practices cannot be applied to government. It is in all of our best interests to see that government revenues are spent in efficient and cost effective ways. We believe that the Capital Budget process played a crucial role in helping corporations make the right investment decisions which have helped to transform our global competitiveness. We believe that it can play a similarly crucial role for the government as well.
To that end, FEI has worked for over 15 years promoting the need for improved financial management practices in Federal government. Seven years have passed since the passage of the Chief Financial Officers Act of 1990. Much has been accomplished, but much more remains to be done. We believe this period of prosperity provides a unique opportunity to significantly improve Federal Financial Management while at the same time taking a long, hard look at updating the Federal Budget Process. The time is right to get the Federal government's fiscal house in order, and we stand ready to assist this Commission to accomplish these long overdue objectives.
Thank you for this opportunity to appear before the Commission this afternoon. I would be pleased to answer any questions.